UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2005

COMMISSION FILE NUMBER: 000-24539

ECLIPSYS CORPORATION

(Exact name of registrant as specified in its charter)

DELAWARE (State of Incorporation)		65-0632092 (IRS Employer Identification Number)

(Address of principal executive offices)

(Telephone number of registrant)

     Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing for the past 90 days. Yes þ No o

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes þ No o

     Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date.

Class		Shares outstanding as of August 1, 2005
Common Stock, $.01 par value		48,736,198

 

 

ECLIPSYS CORPORATION

FORM 10-Q

FOR THE QUARTER ENDED JUNE 30, 2005

INDEX

		Page
PART I. Financial Information
Item 1. Condensed Consolidated Balance Sheets (unaudited) — As of June 30, 2005 and December 30, 2004			3
Condensed Consolidated Statements of Operations (unaudited) — For the Three and Six Months ended June 30, 2005 and 2004			4
Condensed Consolidated Statements of Cash Flows (unaudited) — For the Three and Six Months ended June 30, 2005 and 2004			5
Notes to Condensed Consolidated Financial Statements (unaudited)			6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			11
Item 3. Quantitative and Qualitative Disclosures About Market Risk			27
Item 4. Controls and Procedures			27
PART II. Other Information
Item 1. Legal Proceedings			28
Item 4. Submission of Matters to a Vote of Security Holders			28
Item 6. Exhibits			29
Signatures			29

     PART I.

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

     This report contains forward-looking statements that are based on our current expectations, assumptions, estimates and projections about our company and our industry. When used in this report, the words “may,” “will,” “should,” “predict,” “continue,” “plans,” “expects,” “anticipates,” “estimates,” “intends,” “believe,” and “could,” and similar expressions are intended to identify forward-looking statements. These statements may include, but are not limited to, statements concerning our anticipated performance, including revenue, margin, cash flow, balance sheet and profit expectations; development and implementation of our software; duration, size, scope and revenue expectations associated with client contracts; benefits provided by Eclipsys software, outsourcing and consulting services; business mix; sales and growth in our client base; market opportunities; industry conditions; and our accounting, including its effects and potential changes in accounting.

     Actual results might differ materially from the results projected due to a number of risks and uncertainties. Software development may take longer and cost more than expected, and incorporation of anticipated features and functionality may be delayed, due to various factors including programming and integration challenges and resource constraints. We may change our product strategy in response to client requirements, market factors, resource availability, and other factors. Implementation of some of our software is complex and time consuming. Results depend upon a variety of factors and can vary by client. Each client’s circumstances may include unforeseen issues that make it more difficult or costly than anticipated to implement or derive benefit from software, outsourcing or consulting services. The success and timeliness of our services often depends at least in part upon client involvement, which can be difficult to control. We are required to meet specified performance standards, and contracts can be terminated or their scope reduced under certain circumstances. Competition is vigorous, and competitors may develop more compelling offerings or offer more aggressive pricing. New business is not assured and existing clients may migrate to competing offerings. Financial performance targets might not be achieved due to various risks, including slower-than-expected business development or new account implementation, or higher-than-expected costs to develop products, meet service commitments or sign new contracts. Our cash consumption may exceed expected levels if profitability does not meet expectations or strategic opportunities require cash investments. These and other risks and uncertainties are described in this report under the headings “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in our other filings made from time to time with the Securities and Exchange Commission. The cautionary statements made in this report should be read as being applicable to all related forward-looking statements wherever they appear. These statements are only predictions. We cannot guarantee future results, levels of activity, performance or achievements. We assume no obligation to publicly update or revise these forward-looking statements for any reason, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future. We nonetheless reserve the right to make such updates from time to time without the need for specific reference to this report. No such update shall be deemed to indicate that other statements not addressed by such updates remain correct or create an obligation to provide any other updates.

Executive Overview

     Eclipsys is a healthcare information technology company. We develop and license our proprietary software and content to hospitals and other healthcare organizations. Our software allows the organizations to automate many of the key clinical, administrative and financial functions that they require. Our software is designed to improve patient care and patient satisfaction for our customers, and allow them to reduce their operating costs and enhance their revenues. Our content provides practice guidelines for use in hospitals and other healthcare organizations.

     Our Web site address is www.eclipsys.com. We make available free of charge, on or through our Web site, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission.

Background

     We were founded in December 1995 and initially grew through a series of strategic acquisitions completed through 1999. Our acquisitions were focused on acquiring strong customer bases and advanced software for the healthcare industry.

     In addition to these acquisitions, in 1996 we licensed certain intellectual property on an exclusive basis from Partners HealthCare System, Inc., or Partners. This intellectual property related to clinical workflows including order management and clinical decision support. The Partners technology has been incorporated within our product offerings.

     In March 2004, we acquired CPM Resource Center, Ltd., or CPMRC. CPMRC provides consulting services and clinical content designed principally to improve and enhance the care process primarily related to the workflow of nurses and interdisciplinary healthcare professionals who provide the majority of hands-on care at the point of service. CPMRC’s evidence-based content and

practice guidelines have been incorporated into the current release of our SunriseXA software.

     In December of 2004, we acquired eSys Medical Inc. (eSys). eSys develops and markets radiology information systems, or RIS. We believe eSys’ RIS will enhance our diagnostic imaging solution and extend our clinical workflow solutions in radiology.

Product Development

     In June 1999, we began re-expressing the intellectual property that we acquired through acquisitions on a common platform to provide integrated software to our customers. In 1999, we announced the general availability of Sunrise Clinical Manager, or SCM, the first version of our Sunrise^tm suite of software products. SCM provides advanced knowledge-based clinical decision-support capabilities including computerized physician order entry.

     In 2001, we announced our SunriseXA^tm strategy. This strategy was to migrate our Sunrise suite of products to an open architecture and platform. SunriseXA’s architecture is built on Microsoft’s .NET Framework, Microsoft SQL Server and the Microsoft Windows family of operating systems. In 2002 and 2003, we announced the general availability of certain components of our SunriseXA product offerings.

     In October 2003, we identified and announced response time issues within components of SunriseXA. Although some of our SunriseXA software components had been implemented in and were working at some customer sites, we determined that the software did not produce acceptable response times for complex, high-volume hospital environments. To address the issue, we implemented a strategy that was designed to allow SunriseXA customers to continue their deployment of SunriseXA which would, at the same time, allow us to continue the development of advanced SunriseXA solutions. This strategy replaced the affected SunriseXA components with components from our SCM product, which is our prior generation, core clinical product. The response time issue resulted in a product delivery delay for some of our advanced SunriseXA functionality. The announcement of these issues also impacted the implementation schedules for a number of our customers. As previously disclosed, this announcement had an adverse effect on our sales for 2004.

     In June 2004, we released Sunrise Clinical Manager 3.5 XA and in March 2005 we released Sunrise Clinical Manager 4.0 XA. The general availability of these releases fulfilled key deliverables expected by our customers in connection with the SunriseXA response time issue. These releases were consistent with our strategy and contained enhanced functionality as planned.

Operational Initiatives

     During 2001, our management made two strategic decisions that significantly impacted our operating results. First, we substantially increased our gross research and development spending, which includes research and development expenses and capitalized software development costs. This decision was made to enable us to bring components of our SunriseXA product line to market more rapidly. Second, we invested heavily in sales and marketing to enhance market awareness surrounding Eclipsys and its products and services. We did this to capitalize on perceived market demand for our products and services. Additionally, in 2002, we moved aggressively to change our contracting model, offering our customers payment terms which are more evenly distributed over the term of the contract compared to the traditional licensing model we used previously, in which software license fees were paid in advance. We did this to meet the needs of our customers, by matching the timing of their payments to the value that we deliver to them. We believe that this contracting model makes purchasing decisions easier for our customers.

     The change in our contracting model has had a material affect on our business. Most notably, our revenues, gross margins, and cash flows have been affected by our adoption of this approach. Because the payments from our customers for software license fees are more evenly distributed over the term of the contract, our revenue from a particular transaction is recognized over a longer period of time compared to the traditional licensing model, while a significant portion of our operating expenses remain relatively fixed and are recognized early in the contract term. For example, in 2003, our gross margins, operating margins, and cash flow from operating activities were negatively affected by lower upfront software payments. However, we believe that this contracting model provides for more predictable revenues on a year-over-year basis.

     During the quarter-ended June 30, 2005, we announced that Eugene V. Fife our Chairman of the Board of Directors had been named interim Chief Executive Officer and President, replacing Paul L. Ruflin who had left the company. Mr. Fife will also continue to serve as the Chairman of our Board of Directors. We are currently in the process of recruiting a long-term Chief Executive Officer.

     We consumed cash in 2003, 2004 and the first half of 2005, primarily because cash collections under our new contracting method from new contract signings were not sufficient to offset our higher operating expenses. To fund our business, we used a portion of our cash on hand.

Operational Environment and Other Challenges for 2005

     During the fourth quarter of 2004, we experienced a slow down in sales transactions as a result of increasing competition within our sector, and this has continued through the first half of 2005. New sales in 2005 are the primary source of revenue growth for 2006. As a result of the 2005 sales performance to date, achieving our objectives for 2006 revenue growth depends significantly on

sales results in the second half of 2005. We expect that competition may continue to intensify, which could result in delayed sales, pricing pressures, a decrease in profitability on new contracts or a loss of future business. Additionally, we have a significant number of customers scheduled to go live on one or more modules of our software applications throughout 2005. The successful implementation of these customers will be critical to our success. We released Sunrise Clinical Manager 4.0 XA in March of 2005 and we are scheduled to release Sunrise Clinical Manager 4.5 XA during the fourth quarter of 2005. If we experience a delay in future releases, or they do not achieve market acceptance, our business may suffer.

Critical Accounting Policies

     We believe there are several accounting policies that are critical to understanding our historical and future performance, as these policies affect the reported amount of revenue and other significant areas involving management’s judgments and estimates. On an ongoing basis, management evaluates and adjusts its estimates and judgments, if necessary. These significant accounting policies relate to revenue recognition, allowance for doubtful accounts, capitalized software development costs and our warranty reserve. Please refer to Note 2 of the audited consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2004 as filed with the SEC on March 16, 2005, for further discussion of our accounting policies, which have not changed materially since our filing.

Revenue Recognition

     We generally contract under multiple element arrangements, which include software license fees, hardware and services including consulting, implementation, and software maintenance, for periods of 3 to 10 years. We evaluate revenue recognition on a contract-by-contract basis as the terms of each arrangement vary. The evaluation of our contractual arrangements often requires judgments and estimates that affect the timing of revenue recognized in our statements of operations. Specifically, we may be required to make judgments about:

	•		whether the fees associated with our products and services are fixed or determinable;
	•		whether collection of our fees is reasonably assured;
	•		whether professional services are essential to the functionality of the related software product;
	•		whether we have the ability to make reasonably dependable estimates in the application of the percentage-of-completion method; and
	•		whether we have verifiable objective evidence of fair value for our products and services.

     We recognize revenues in accordance with the provisions of Statement of Position, or SOP, No. 97-2, “Software Revenue Recognition” as amended by SOP No. 98-9, Staff Accounting Bulletin, or SAB, 104, “Revenue Recognition” and Emerging Issues Task Force, or EITF 00-21, “Revenue Arrangements with Multiple Deliverables.” SOP 97-2 and SAB 104, as amended, require, among other things, that there be a signed contract evidencing that an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collectibility is probable.

     Many of our contracts with our customers are multiple element arrangements, which may provide for multiple software products, including the rights to future products we may offer within the software suites the customer purchases or rights to software versions that support different hardware or operating platforms, and that do not qualify as exchange rights. We refer to these arrangements as subscription contracts. Additionally, we sometimes enter into multiple element arrangements that do not include these rights to future products or platform protection rights. We refer to these arrangements as traditional software contracts. Finally, we offer many of our products and services on a stand-alone basis. Revenue under each of these arrangements is recognized as follows:

Subscription Contracts

     Our subscription contracts typically include the following deliverables:

	•		software license;
	•		maintenance;
	•		professional services; and
	•		third party hardware or remote hosting services.

     Software license fees are recognized ratably over the term of the contract, commencing upon the delivery of the software provided that (1) there is evidence of an arrangement, (2) the fee is fixed or determinable and (3) collection of our fee is considered probable. The value of the software is determined using the residual method pursuant to Statement of Position 98-9, “Modification of Statement of Position 97-2 With Respect to Certain Transactions,” or SOP 98-9. These contracts contain the rights to unspecified future products

within the product suite purchased and/or unspecified platform transfer rights that do not qualify for exchange accounting. Accordingly, these arrangements are accounted for pursuant to paragraphs 48 and 49 of Statement of Position 97-2, “Software Revenue Recognition,” or SOP 97-2. Under certain arrangements, we capitalize related direct costs consisting of third party software costs and direct software implementation costs. These costs are amortized over the term of the arrangement.

     In the case of maintenance revenues, vendor-specific objective evidence, or VSOE, of fair value is based on substantive renewal prices, and the revenues are recognized ratably over the maintenance period.

     In the case of professional services revenues, VSOE is based on prices from stand-alone sale transactions, and the revenues are recognized as services are performed pursuant to paragraph 65 of SOP 97-2.

     Third party hardware revenues are recognized upon delivery, pursuant to SAB 104.

     In the case of remote hosting services, where VSOE is based upon consistent pricing charged to customers based on volumes and performance requirements on a stand-alone basis and substantive renewal terms, the revenues are recognized ratably over the contract term as the services are performed. Our remote hosting arrangements generally require us to perform one-time set-up activities and include a one-time set-up fee. This one-time set-up fee is generally paid by the customer at contract execution. We have determined that these set-up activities do not constitute a separate unit of accounting, and accordingly the related set-up fees are recognized ratably over the term of the contract.

     We consider the applicability of Emerging Issues Task Force 00-3, or EITF 00-3, “Application of AICPA Statement of Position 97-2 to Arrangements That Include the Right to Use Software Stored On Another Entity’s Hardware,” to our remote hosting services arrangements on a contract-by-contract basis. If we determine that the customer has the contractual right to take possession of our software at any time during the hosting period without significant penalty, and can feasibly run the software on its own hardware or enter into another arrangement with a third party to host the software, a software element covered by SOP 97-2 exists. When a software element exists in a remote hosting services arrangement, we recognize the license, professional services and remote hosting services revenues pursuant to SOP 97-2, whereby the fair value of the remote hosting services is recognized as revenue ratably over the term of the remote hosting contract. If we determine that a software element covered by SOP 97-2 is not present in a remote hosting services arrangement; we recognize revenue for the remote hosting services arrangement ratably over the term of the remote hosting contract pursuant to SAB 104.

Traditional Software Contracts

     We enter into traditional multiple-element arrangements that include the following elements:

	•		software license;
	•		maintenance;
	•		professional services; and
	•		third party hardware or remote hosting services.

     Revenue for each of the elements is recognized as follows:

     Software license fees are recognized upon delivery of the software provided that (1) there is evidence of an arrangement, (2) the fee is fixed or determinable and (3) collection of our fee is considered probable. For those arrangements in which the fee is not considered fixed or determinable, the software license revenue is recognized as the payments become due. For arrangements where VSOE only exists for the undelivered elements, we account for the delivered elements (software license revenue) using the residual method in accordance with SOP 98-9.

     In addition to the software license fees, these contracts may also contain maintenance, professional services and hardware or remote hosting services. VSOE and revenue recognition for these elements is determined using the same methodology as noted above for subscription contracts.

Software Contracts Requiring Contract Accounting

     We enter into multiple element arrangements containing milestone provisions in which the professional services are considered essential to the functionality of the software. Under these arrangements, software license fees and professional service revenues are recognized using the percentage-of-completion method over the implementation period, which generally ranges from 12 to 24 months. Under the percentage-of-completion method, revenue and profit are recognized throughout the term of the implementation based upon estimates of total labor hours incurred and revenues to be generated over the term of the implementation. Changes in estimates of total labor hours and the related effect on the timing of revenues and profits are recognized in the period in which they are determinable. Accordingly, changes in these estimates could occur and have a material effect on our operating results in the period of change.

Stand-Alone Products and Services

     We also market products and services on a stand-alone basis. These products and services include the following:

	•		software license;
	•		maintenance;
	•		professional services;
	•		hardware;
	•		network services;
	•		remote hosting services;
	•		outsourcing.

Revenue related to these products and services is recognized as follows:

     Software license fees and maintenance are marketed on a stand-alone basis and may be licensed either under traditional contracts or under subscription arrangements. Software license fees under traditional contracts are recognized pursuant to SOP 97-2 if, when the software has been delivered, persuasive evidence of an arrangement exists, the fee is fixed or determinable and collectibility is probable. Under subscription agreements for stand-alone products, software license fees are recognized ratably over the term of the contract. With respect to maintenance, VSOE is determined based on substantive renewal prices contained in the contracts. Maintenance is recognized ratably over the term of the contract.

     Professional services represent incremental services marketed to customers including implementation and consulting services. Professional services revenues, where VSOE is based on prices from stand-alone transactions, are recognized as services are performed.

     Hardware is recognized upon delivery pursuant to SAB 104.

     Network services arrangements include the assessment, assembly and delivery of a wireless network, which may include wireless carts or other wireless equipment to the customer. Our network services arrangements are sold to a customer for a fixed fee. All services are performed prior to the delivery of the equipment. These contracts are typically 60 to 90 days in length and are recognized pursuant to SAB 104, upon the delivery of the network to the customer.

     Remote hosting contracts that are sold on a stand-alone basis are recognized ratably over the contract term pursuant to SAB 104. Our remote hosting arrangements generally require us to perform one-time set-up activities and include a one-time set-up fee. This one-time set-up fee is generally paid by the customer at contract execution. We have determined that these set-up activities do not constitute a separate unit of accounting, and accordingly we recognize the related set-up fees ratably over the term of the contract.

     We provide outsourcing services to our customers. Under these arrangements we assume all responsibilities for a healthcare organization’s information technology operations using our employees. Our outsourcing services include facilities management, network outsourcing and transition management. These arrangements typically range from five to ten years in duration. Revenues from these arrangements are recognized when services are performed.

     If other judgments or assumptions had been used in the evaluation of our revenue arrangements, the timing and amounts of revenue recognized might have been significantly different.

Allowance for Doubtful Accounts

     In evaluating the collectibility of our accounts receivable, we assess a number of factors, including a specific customer’s ability to meet its financial obligations to us, as well as general factors such as the length of time the receivables are past due and historical collection experience. Based on these assessments, we record a reserve for specific account balances as well as a reserve based on our historical experience for bad debt to reduce the related receivables to the amount we ultimately expect to collect from customers. If circumstances related to specific customers change, or economic conditions deteriorate such that our past collection experience is no longer relevant, our estimate of the recoverability of our accounts receivable could be further reduced from the levels provided for in our consolidated financial statements.

Capitalized Software Development Costs

     We capitalize software development costs in accordance with FASB Statement No. 86, “Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed.” We capitalize software development costs incurred subsequent to establishing

technological feasibility of the software being developed. These costs include salaries, benefits, consulting and other directly related costs incurred in connection with coding and testing software products. Capitalization ceases when the products are generally released for sale to customers, at which time amortization of the capitalized costs begins. This amortization is reflected in the costs of systems and services revenues. At each balance sheet date, we perform a detailed assessment of our capitalized software development costs, which includes a review of, among other factors, projected revenues, customer demand requirements, product lifecycle, changes in software and hardware technologies, and product development plans. Based on this analysis we record adjustments, when appropriate, to reflect the net realizable value of our capitalized software development costs. The estimates of expected future revenues generated by the software, the remaining economic life of the software, or both, could change, materially affecting the carrying value of capitalized software development costs, as well as our consolidated operating results in the period of change.

Warranty Reserve

     The agreements that we use to license our software include a limited warranty. The warranty provides that our software, in its unaltered form, will perform substantially in accordance with the related documentation. Through September 30, 2003 we did not incur any material warranty costs related to our products. In October 2003, we identified and announced response time issues within components of SunriseXA. Although some of our SunriseXA software components had been implemented in and were working at some customer sites, we determined that the software did not produce acceptable response times for complex, high-volume hospital environments. The response time issue resulted in a product delivery delay for some of our advanced SunriseXA functionality. The announcement of these issues also impacted the implementation schedules for a number of our customers. In connection with this issue, we have recorded warranty provisions to date of $4.6 million.

     Warranty costs are charged to costs of systems and services revenues when they are probable and reasonably estimable. In determining this warranty reserve, we used significant judgments and estimates for the additional professional service hours and third party costs that will be necessary to remedy this issue on a customer-by-customer basis. The timing and amount of our warranty reserve could have been different if we had used other judgments or assumptions in our evaluation.

THREE MONTHS ENDED JUNE 30, 2005 COMPARED TO THREE MONTHS ENDED JUNE 30, 2004

Eclipsys Corporation
Statement of Operations Data — Unaudited
(in thousands, except per share amounts)

		Three Months Ended June 30,
						% of Total								% of Total
		2005				Revenues				2004				Revenues				Change $				Change %
Revenues
Systems and services		$	91,557				95.5	%		$	68,597				93.1	%		$	22,960				33.5	%
Hardware			4,308				4.5	%			5,046				6.9	%			(738	)			-14.6	%
Total revenues			95,865				100.0	%			73,643				100.0	%			22,222				30.2	%
Costs and expenses
Costs of systems and services revenues			55,248				57.6	%			41,795				56.8	%			13,453				32.2	%
Costs of hardware revenues			3,557				3.7	%			4,337				5.9	%			(780	)			-18.0	%
Sales and marketing			16,196				16.9	%			15,458				21.0	%			738				4.8	%
Research and development			13,974				14.6	%			14,536				19.7	%			(562	)			-3.9	%
General and administrative			6,511				6.8	%			4,407				6.0	%			2,104				47.7	%
Depreciation and amortization			3,583				3.7	%			3,295				4.5	%			288				8.7	%
Total costs and expenses			99,069				103.3	%			83,828				113.8	%			15,241				18.2	%
Loss from operations			(3,204	)			-3.3	%			(10,185	)			-13.8	%			6,981				68.5	%
Interest income, net			719				0.8	%			225				0.3	%			494				219.6	%
Loss before income taxes			(2,485	)			-2.6	%			(9,960	)			-13.5	%			7,475				75.1	%
Provision for income taxes			—								—
Net loss		$	(2,485	)			-2.6	%		$	(9,960	)			-13.5	%		$	7,475				75.1	%
Basic net loss per share		$	(0.05	)						$	(0.21	)						$	0.16
Diluted net loss per share		$	(0.05	)						$	(0.21	)						$	0.16

RESULTS OF OPERATIONS

     Total revenues increased $22.2 million, or 30.2%, to $95.9 million for the quarter-ended June 30, 2005, compared with $73.6 million for the second quarter of 2004.

     Systems and services revenues increased $23.0 million, or 33.5%, to $91.6 million for the quarter-ended June 30, 2005, compared with $68.6 million for the second quarter of 2004. Systems and services revenues increased primarily as a result of an increase in revenues generated under long-term contracts including increases in software, software maintenance, outsourcing and remote hosting. These revenues, which are generally recognized ratably over the term of the respective agreements, increased by $14.6 million, or 30.1%. The increase in these revenues was associated with incremental revenues related to contracts that were entered into during the second half of 2004 and Q1 2005 and progress made on customer implementations. Additionally, in conjunction with these contracts, professional services revenues, which include implementation and consulting services, were $21.2 million, an increase of $6.6 million, or 45.6%. The increase in professional services was driven by a higher level of revenues associated with customer activations and ongoing consulting projects at numerous customer sites. A significant level of the activity was associated with the activation of our clinical software suite which includes Sunrise Clinical Manager 3.5 XA and 4.0 XA. The release of these products occurred in June 2004 and March 2005, respectively. These releases of our product contained incremental functionality of our core clinical offering which includes an electronic medical record and computerized physician order entry. Additionally, these offerings expanded the workflow capabilities of our software products to enable the software to function within the ambulatory, emergency department and medication management venues of care. The increase in volume of professional services is expected to continue throughout the remainder of 2005 as a significant number of our customers continue to activate our applications. Our continued growth in systems and services revenues in 2006 will require increased sales in the second half of 2005.

     Hardware revenues decreased $738,000, or 14.6%, to $4.3 million for the quarter-ended June 30, 2005, compared with $5.0 million for the second quarter of 2004. Hardware revenues in 2005 are expected to remain at levels that are lower than 2004 as a significant number of customers purchased hardware in the prior year based on the scheduled activation of their respective implementations. Additionally, sales volumes of hardware decreased as some customers have elected to obtain remote hosting services from us in lieu of hardware purchases in connection with the purchase of our applications.

     Costs of systems and services revenues increased $13.5 million, or 32.2%, to $55.2 million, for the quarter-ended June 30, 2005, compared to $41.8 million for the second quarter of 2004. Gross margins on systems and services revenues were 39.7% for the quarter-ended June 30, 2005, compared to 39.1% for the second quarter of 2004. The increase in costs of systems and services

revenues was primarily a result of incremental costs associated with higher levels of outsourcing and remote hosting revenues. Additionally, costs in the quarter increased as a result of a higher level of third party consulting costs used to supplement the delivery of implementation and consulting services on our customer projects. Furthermore, the amortization of capitalized software development costs increased by $2.0 million primarily as a result of the releases of our clinical product suite in 2004 and 2005.

     Costs of hardware revenues decreased $780,000, or 18.0%, to $3.6 million for the quarter-ended June 30, 2005, compared to $4.3 million for the second quarter of 2004. Gross margins on hardware revenues were 17.4% in the second quarter of 2005 and 14.1% in the second quarter of 2004. The decrease in the costs of hardware revenues was a result of lower hardware volume.

     Sales and marketing expenses increased $738,000 or 4.8%, to $16.2 million for the quarter-ended June 30, 2005, compared to $15.5 million for the second quarter of 2004. The increase in sales and marketing expenses was primarily related to an increase in payroll, training and travel costs.

     Research and development expenses decreased $562,000, or 3.9%, to $14.0 million, for the quarter-ended June 30, 2005, compared to $14.5 million for the second quarter of 2004. Research and development costs decreased as a result of a $1.3 million reduction in expenditures, offset by lower capitalized software development costs. Capitalized software development costs were $3.2 million in the quarter-ended June 30, 2005 compared to $3.9 million in the quarter-ended June 30, 2004. The higher level of capitalized software development costs in 2004 was due to increased costs associated with coding, testing and other activities associated with the release of Sunrise Clinical Manager 3.5 XA, which was made generally available in June 2004. In 2005, the capitalized software development costs relate to activities associated with our Sunrise Clinical Manger 4.5 XA release which is scheduled for general availability in the fourth quarter of 2005. Amortization of capitalized software development costs, which is included as a component of costs of systems and services revenues, increased by approximately $2.0 million, to $3.9 million for the three months ended June 30, 2005, compared to $1.9 million for second quarter of 2004. The increase in amortization is the result of releases of Sunrise Clinical Manager 3.5 XA and 4.0 XA.

     General and administrative expenses increased $2.1 million, or 47.7%, to $6.5 million for the quarter-ended June 30, 2005, compared to $4.4 million for the second quarter of 2004. Included in general and administrative expenses is $2.2 million of costs associated with the transition of our prior Chief Executive Officer. Without these costs, general and administrative expenses in the quarter-ended June 30, 2005 were essentially unchanged.

     Depreciation and amortization increased $288,000, or 8.7%, to $3.6 million, for the quarter-ended June 30, 2005, compared to $3.3 million, for the second quarter of 2004. The increase was primarily the result of higher depreciation related to fixed assets purchased in our continued effort to expand our research and development infrastructure and to increase capacity at our Technology Solutions Center.

     Interest income increased $494,000, or 219.6%, to $719,000 for the quarter-ended June 30, 2005, compared to $225,000 for the second quarter of 2004. The increase was due to a significant improvement in yields resulting from higher interest rates in the quarter.

     As a result of these factors, we had a net loss of $2.5 million for the quarter-ended June 30, 2005, compared to a net loss of $10.0 million for the second quarter in 2004.

SIX MONTHS ENDED JUNE 30, 2005 COMPARED TO SIX MONTHS ENDED JUNE 30, 2004

Eclipsys Corporation
Statement of Operations Data — Unaudited
(in thousands)

		Six Months Ended June 30,
						% of Total								% of Total
		2005				Revenues				2004				Revenues				Change $				Change %
Revenues
Systems and services		$	174,685				96.9	%		$	130,404				91.8	%		$	44,281				34.0	%
Hardware			5,615				3.1	%			11,623				8.2	%			(6,008	)			-51.7	%
Total revenues			180,300				100.0	%			142,027				100.0	%			38,273				26.9	%
Costs and expenses
Costs of systems and services revenues			107,513				59.6	%			81,133				57.1	%			26,380				32.5	%
Costs of hardware revenues			4,658				2.6	%			9,971				7.0	%			(5,313	)			-53.3	%
Sales and marketing			34,372				19.1	%			31,399				22.1	%			2,973				9.5	%
Research and development			26,550				14.7	%			29,273				20.6	%			(2,723	)			-9.3	%
General and administrative			10,867				6.0	%			7,576				5.3	%			3,291				43.4	%
Depreciation and amortization			7,266				4.0	%			6,377				4.5	%			889				13.9	%
Total costs and expenses			191,226				106.1	%			165,729				116.7	%			25,497				15.4	%
Loss from operations			(10,926	)			-6.1	%			(23,702	)			-16.7	%			12,776				53.9	%
Interest income, net			1,280				0.7	%			679				0.5	%			601				88.5	%
Loss before income taxes			(9,646	)			-5.3	%			(23,023	)			-16.2	%			13,377				58.1	%
Provision for income taxes			—								—
Net loss		$	(9,646	)			-5.3	%		$	(23,023	)			-16.2	%		$	13,377				58.1	%
Basic net loss per share		$	(0.20	)						$	(0.50	)						$	0.30
Diluted net loss per share		$	(0.20	)						$	(0.50	)						$	0.30

RESULTS OF OPERATIONS

     Total revenues increased $38.3 million, or 26.9%, to $180.3 million for the six months ended June 30, 2005, compared with $142.0 million for the same period in 2004.

     Systems and services revenues increased $44.3 million, or 34.0 %, to $174.7 million for the six months ended June 30, 2005, compared with $130.4 million for the same period in 2004. Systems and services revenues increased primarily as a result of an increase in revenues generated under long-term contracts including increases in software, software maintenance, outsourcing and remote hosting. These revenues, which are generally recognized on a monthly basis, increased by $27.2 million, or 28.5%. The increase in revenues was a result of higher revenues in connection with contracts entered into the second of half of 2004 and Q1 2005. Additionally, revenues related to our remote hosting offering increased as more customers have elected this service in lieu of purchasing hardware. Furthermore, systems and services revenues were favorably impacted by progress made in connection with customer implementations, which resulted in higher software and software maintenance revenues. Additionally, in connection with these long-term contracts, professional services revenues increased to $37.4 million, or 41.7%, an increase of $11.0 million. The increase in professional services was driven by a higher level of revenues associated with customer activations and ongoing consulting projects at numerous customer sites. A significant level of this activity was associated with the activation of our clinical software suite which includes Sunrise Clinical Manager 3.5 XA and 4.0 XA. The higher level of professional services is expected to continue throughout the remainder of 2005 as we continue to activate numerous customers on the newest releases of our software product. Our continued growth in systems and services revenues in 2006 will require increased sales in the second half of 2005.

     Hardware revenues decreased $6.0 million, or 51.7%, to $5.6 million for the six months ended June 30, 2005, compared with $11.6 million for the same period in 2004. As previously mentioned, 2005 hardware revenues are expected to remain at levels that are lower than 2004 due to the change in sales mix related to the purchase of remote hosting services in lieu of hardware purchases by our customers and a lower level of hardware volume associated with the status of customer implementations compared to the prior year.

     Costs of systems and services revenues increased $26.4 million, or 32.5%, to $107.5 million, for the six months ended June 30, 2005, compared to $81.1 million for the same period in 2004. Gross margins on systems and services revenues were 38.5% for the six months ended June 30, 2005, compared to 37.4% for the same period in 2004. The increase in costs of systems and services revenues was largely a result of incremental costs associated with higher levels of outsourcing and remote hosting revenues. Additionally, costs in the period increased as a result of a higher level of third party consulting costs used to supplement our delivery of services in connection with customer implementation and consulting projects. Furthermore, the amortization of capitalized software development

costs increased by $3.3 million as a result of the releases of our clinical product suite in 2004 and 2005.

     Costs of hardware revenues decreased $5.3 million, or 53.3%, to $4.7 million for the six months ended June 30, 2005, compared to $10.0 million for the same period in 2004. Gross margins on hardware revenues were 17.0% in the six months ended June 30, 2005 and 14.2% in the same period in 2004. The decrease in the costs of hardware revenues was attributable to the decrease in hardware revenues discussed above.

     Sales and marketing expenses increased $3.0 million, or 9.5%, to $34.4 million for the six months ended June 30, 2005, compared to $31.4 million for the same period in 2004. The increase in sales and marketing expenses was primarily related to increases in payroll related costs including incentive compensation related costs, travel, training and costs associated with marketing events.

     Research and development expenses decreased $2.7 million, or 9.3%, to $26.6 million, for the six months ended June 30, 2005, compared to $29.3 million for the same period in 2004. The decrease in research and development expenses was primarily related to an increase in capitalized software development costs and lower overall expenditures. Capitalized software development costs increased to $9.6 million in 2005 compared to $8.5 million in 2004. The increase in capitalized software development costs was related to development efforts in connection with the release of Sunrise Clinical Manger 4.0 XA which was made generally available in March 2005 and activities associated with the completion of Sunrise Clinical Manager 4.5 XA which is currently scheduled to be released at the end of 2005.

     General and administrative expenses increased $3.3 million, or 43.4%, to $10.9 million for the six months ended June 30, 2005, compared to $7.6 million for the same period in 2004. As mentioned earlier, 2005 general and administrative expenses include $2.2 million of costs associated with the transition of our former Chief Executive Officer. Additionally, these expenses further increased as a result of incremental payroll related costs and professional services.

     Depreciation and amortization increased $889,000 or 13.9%, to $7.3 million, for the six months ended June 30, 2005, compared to $6.4 million, for the same period in 2004. The increase was primarily the result of higher depreciation related to computer purchases at our Technology Solutions Center and incremental amortization associated with acquisitions which were completed in 2004.

     Interest income increased $601,000, or 88.5%, to $1.3 million for the six months ended June 30, 2005, compared to $679,000 for the same period in 2004. The increase was due to an improvement in yields resulting from higher interest rates in the quarter.

     As a result of these factors, we had a net loss of $9.6 million for the six months ended June 30, 2005, compared to a net loss of $23.0 million for the same period in 2004.

LIQUIDITY AND CAPITAL RESOURCES

     During the quarter-ended June 30, 2005, operating activities generated $1.7 million of cash, primarily related to the collection of accounts receivables from customers and an overall improvement in our results of operations. Investing activities used $5.7 million of cash, primarily related to $3.2 million of capitalized software development costs and $2.2 million of capital expenditures. Financing activities provided $5.9 million of cash from the exercise of stock options. For the six months ended June 30, 2005, operating activities used $5.4 million of cash, primarily related to up-front costs in connection with a significant outsourcing contract, costs associated with the Chief Executive Officer transition and payments made in conjunction with prior year employee incentive compensation plans. These items were partially offset by improvements in our results of operations. Investing activities used $53.1 million of cash, primarily related to $9.6 million of capitalized software development costs, $6.3 million of capital expenditures and $37.2 million of purchases of marketable equity securities. Financing activities provided $7.6 million of cash from the exercise of stock options.

     As of June 30, 2005, our principal source of liquidity is our combined cash and marketable securities balance of $108.4 million. Our future liquidity requirements will depend on a number of factors including, among other things, the timing and volume of our new sales, the cost of our development efforts, the success and market acceptance of our future product releases, and other related items. As of June 30, 2005, we did not have any material commitments for capital expenditures. We believe that our current cash and marketable securities balances, combined with our anticipated cash collections from customers will be adequate to meet our liquidity requirements through 2005.

Risk Factors

     There are a number of important factors that could affect our business and future operating results, including without limitation, the factors set forth below. The information contained in this report should be read in light of such factors. Any of the following factors could harm our business and future operating results.

We face risks relating to our product strategy

     In October 2003, we announced the existence of certain response time issues within some components of SunriseXA, the newest version of our Sunrise family of products. We concluded that the root cause of the issue was in the technical design of SunriseXA, which did not adequately support the throughput required in the highly interactive patient care environment. After substantial analysis,

we pursued and continue to pursue a strategy that we believe addresses these issues. Our strategy was to replace the affected SunriseXA components with certain components from our SCM product, which is our prior generation, core clinical product. Although we believe that the releases of Sunrise Clinical Manager 3.5 XA in June 2004 and Sunrise Clinical Manager 4.0 XA in March 2005 were significant milestones in the implementation of our product strategy, we continue to face a variety of risks and uncertainties in this regard including among others, the following:

	•		We may encounter technical obstacles and delays in implementing this approach. As we continue to implement our strategy, it is possible that we could discover additional problems with our software.
	•		It is possible future releases of SunriseXA, with anticipated additional features for our products, may be delayed. This could result in delayed or lost sales.
	•		Customers who are currently implementing SunriseXA have faced delays in their implementations. As a result, existing SunriseXA customers could attempt to cancel their contracts with us or seek financial or other concessions from us.
	•		As a result of the changes we will make to our SunriseXA product offering, potential customers may find such products less appealing, which could decrease demand for our products.
	•		2003 operating results reflect a $1.2 million write-down of capitalized software development costs for certain SunriseXA components. Additionally, to date we have recorded warranty related costs of $4.6 million related to the anticipated costs associated with the SunriseXA response time issue.

     These issues could harm our relationships with customers generally and our reputation in the marketplace. This announcement adversely affected our 2004 sales. Additionally, it is possible that this issue may continue to make sales more challenging for the affected SunriseXA applications.

Recent changes in our executive team could distract management and cause uncertainty that could result in delayed or lost sales

     On April 29, 2005, we announced that our Chairman, Eugene V. Fife, replaced Paul L. Ruflin as our President and Chief Executive Officer on an interim basis. At the same time, our board of directors announced that it had initiated a search for a new, long-term Chief Executive Officer. There can be no assurance that we will be able to recruit an appropriate candidate to become our long-term Chief Executive Officer in a timely manner. Any transition of this type could divert our management’s time and attention from the operation of our business and if we do not manage this process effectively, it could cause some level of uncertainty among our customers and potential customers that could lead to delays in closing new business or ultimately in lost sales.

Our product strategy is dependent on the continued development and support by Microsoft of its .Net Framework and other technologies

     Our product strategy is substantially dependent upon Microsoft’s .Net Framework and other Microsoft technologies. The .Net Framework, in particular, is a relatively new and evolving technology. If Microsoft were to cease actively supporting .Net or other technologies, fail to update and enhance them to keep pace with changing industry standards, encounter technical difficulties in the continuing development of these technologies or make them unavailable to us, we could be required to invest significant resources in re-engineering our products. This could lead to lost or delayed sales, unanticipated development expenses and harm to our reputation, and would cause our financial results and business to suffer.

Our software development efforts may not meet the demands of the market or commitments to our clients, which could adversely affect our results of operations

     We continuously strive to develop new software products, and improve our existing software products to add new features and functionality. We schedule and prioritize these development efforts according to a variety of factors, including our perceptions of market trends, client requirements, and resource availability. Our software is complex and requires a significant investment of time and resources to develop, test and introduce into use. Sometimes this takes longer than we expect. Sometimes we encounter unanticipated difficulties that require us to re-direct or scale-back our efforts. Sometimes we change our plans in response to changes in client requirements, market demands, resource availability, regulatory requirements, or other factors. All of this can result in acceleration of some initiatives and delay of others. If we make the wrong choices or do not manage our development efforts well, we may fail to produce software that responds appropriately to clients’ needs, and fail to meet commitments to clients regarding delivery of new or enhanced features and functionality. We have experienced such failures and previous or potential failures of this kind can impair existing customer relationships and new sales, which in turn could have a material adverse effect upon our results of operations.

Given the length of our sales and implementation cycles, if a significant number of our customers delay implementation, our future operating results may suffer

     We have experienced long sales and implementation cycles. How and when to implement, replace, expand or substantially modify an information system, or modify or add business processes, are major decisions for hospitals, our target customer market. Furthermore, our software generally requires significant capital expenditures by our customers. The sales cycle for our software ranges from 6 to 18 months or more from initial contact to contract execution. Historically, our implementation cycle has ranged from 6 to 36 months from contract execution to completion of implementation. During the sales and implementation cycles, we will expend substantial time, effort and financial resources preparing contract proposals, negotiating the contract and implementing the software. We may not realize any revenues to offset these expenditures and, if we do, accounting principles may not allow us to recognize the revenues during corresponding periods. This could harm our future operating results. Additionally, any decision by our customers to delay purchasing or implementing our products may adversely affect our revenues.

Implementation costs may exceed expectations, which can negatively affect our margins

     Some of our software is complex and our implementations may require substantial investments of time and resources by us and our customers. Each customer’s circumstances may include unforeseen issues that make it more difficult or costly than anticipated to implement our software. We may fail to project, price or manage our implementation services correctly, resulting in losses of margin and inefficient use of our implementation staff, which could have a material adverse affect upon our results of operations.

The healthcare industry faces financial constraints that could adversely affect the demand for our products and services

     The healthcare industry faces significant financial constraints. For example, the shift to managed healthcare in the 1990’s put pressure on healthcare organizations to reduce costs, and the Balanced Budget Act of 1997 dramatically reduced Medicare reimbursement to healthcare organizations. Our software often involves a significant financial commitment by our customers. Our ability to grow our business is largely dependent on our customers’ information technology budgets. To the extent healthcare information technology spending declines or increases more slowly than we anticipate, demand for our products would be adversely affected.

We have a history of operating losses and we cannot predict future profitability

     For the first half of 2005, we had a net loss of $9.6 million. We had a net loss of $32.6 million for the year ended December 31, 2004. We also had net losses of $56.0 million in 2003, $29.8 million in 2002, $34.0 million in 2000, $9.4 million in 1999, and $35.3 million in 1998. In 2001, we had net income of $4.4 million, although we had a loss from operations of $1.6 million. We may continue to incur net losses and cannot predict when, or if, we will be profitable in the future.

Our operating results may fluctuate significantly and may cause our stock price to decline

     We have experienced significant variations in revenues and operating results from quarter to quarter. Our operating results may continue to fluctuate due to a number of factors, including:

•

our progress in implementing our strategy to address our SunriseXA response time issues and the level of costs associated with that effort;

	•		the timing, size and complexity of our product sales and implementations;
	•		overall demand for healthcare information technology;
	•		the financial condition of our customers and potential customers;
	•		market acceptance of new services, products and product enhancements by us and our competitors;
	•		customer decisions regarding renewal of their respective contracts;
	•		product and price competition;
	•		the relative proportions of revenues we derive from software, services and hardware;
	•		changes in our operating expenses;
	•		the timing and size of future acquisitions;
	•		personnel changes;

	•		the performance of our products;
	•		significant judgments and estimates made by management in the application of generally accepted accounting principles; and
	•		fluctuations in general economic and financial market conditions, including interest rates.

     It is difficult to predict the timing of revenues that we receive from product sales, because the sales cycle can vary depending upon several factors. These include the size and terms of the transaction, the changing business plans of the customer, the effectiveness of the customer’s management, general economic conditions and the regulatory environment. In addition, the timing of our revenue recognition could vary considerably depending upon the extent to which our customers elect to license our products under arrangements under which revenues are recognized monthly. Generally, less revenue is recognized under these arrangements during the first 12 to 24 months compared to our traditional licensing arrangements. We also continue to offer contracts using our traditional licensing arrangements. Because a significant percentage of our expenses are relatively fixed, a variation in the timing of sales and implementations could cause significant variations in operating results from quarter to quarter. We believe that period-to-period comparisons of our historical results of operations are not necessarily meaningful. Investors should not rely on these comparisons as indicators of future performance.

Because in many cases we recognize revenues for our software monthly over the term of a customer contract, downturns or upturns in sales will not be fully reflected in our operating results until future periods

     We recognize a significant portion of our revenues from customers monthly over the terms of their agreements, which are typically 7 years and can be up to 10 years. As a result, much of the revenues that we report each quarter are attributable to agreements executed during prior quarters. Consequently, a decline in sales, client renewals, or market acceptance of our products in one quarter will not necessarily be reflected in lower revenues in that quarter, and may negatively affect our revenues and profitability in future quarters. In addition, we may be unable to adjust our cost structure to compensate for these reduced revenues. This monthly revenue recognition also makes it difficult for us to rapidly increase our revenues through additional sales in any period, as revenues from new customers must be recognized over the applicable agreement term.

We operate in an intensely competitive market that includes companies that have greater financial, technical and marketing resources than we do

     We operate in a market that is intensely competitive. Our principal competitors include Cerner Corporation, Epic Systems Corporation, GE Medical Systems, IDX Systems Corporation, McKesson Corporation, QuadraMed and Siemens AG. We also face competition from providers of practice management systems, general decision support, database systems and other segment-specific applications, as well as from healthcare IT consultants. A number of existing and potential competitors are more established than we are, and have greater name recognition and financial, technical and marketing resources than we do. We expect that competition will continue to increase, which could lead to a loss of market share or pressure on our prices and could make it more difficult to grow our business profitably.

If the healthcare industry continues to undergo consolidation, this could impose pressure on our products’ prices, reduce our potential customer base and reduce demand for our products

     Many hospitals have consolidated to create larger healthcare enterprises with greater market power. If this consolidation continues, it could erode our customer base and reduce the size of our target market. In addition, the resulting enterprises could have greater bargaining power, which may lead to erosion of the prices for our products.

Potential regulation by the U.S. Food and Drug Administration of our products as medical devices could impose increased costs, delay the introduction of new products and hurt our business

     The U.S. Food and Drug Administration, or FDA, is likely to become increasingly active in regulating computer software or content intended for use in the healthcare setting. The FDA has increasingly focused on the regulation of computer products and computer-assisted products as medical devices under the Food, Drug, and Cosmetic Act, or the FDC Act. If the FDA chooses to regulate any of our products, or third party products that we resell, as medical devices, it could impose extensive requirements upon us, including the following:

	•		requiring us to seek FDA clearance of a pre-market notification submission demonstrating that a product is substantially equivalent to a device already legally marketed, or to obtain FDA approval of a pre-market approval application establishing the safety and effectiveness of the product;
	•		requiring us to comply with rigorous regulations governing the pre-clinical and clinical testing, manufacture, distribution, labeling and promotion of medical devices; and

•

requiring us to comply with the FDC Act regarding general controls including establishment registration, device listing, compliance with good manufacturing practices, reporting of specified device malfunctions and adverse device events.

     If we fail to comply with applicable requirements, the FDA could respond by imposing fines, injunctions or civil penalties, requiring recalls or product corrections, suspending production, refusing to grant pre-market clearance or approval of products, withdrawing clearances and approvals, and initiating criminal prosecution. Any FDA policy governing computer products or content, may increase the cost and time to market of new or existing products or may prevent us from marketing our products.

Changes in federal and state regulations relating to patient data could depress the demand for our products and impose significant product redesign costs on us

     The demand for health care information systems is affected by state and federal laws and regulations that govern the collection, use, transmission and other disclosures of electronic health information. These laws and regulations may change rapidly and may be unclear or difficult to apply.

     Federal regulations under the Health Insurance Portability and Accountability Act of 1996, or HIPAA, imposes national health data standards on healthcare providers that conduct electronic health transactions, healthcare clearinghouses that convert health data between HIPAA-compliant and non-compliant formats and health plans. Collectively, these groups are known as covered entities. The HIPAA standards prescribe transaction formats and code sets for electronic health transactions; protect individual privacy by limiting the uses and disclosures of individually identifiable health information; and require covered entities to implement administrative, physical and technological safeguards to ensure the confidentiality, integrity, availability and security of individually identifiable health information in electronic form. Though we are not a covered entity, most of our customers are and require that our software and services adhere to HIPAA standards. Any failure or perception of failure of our products or services to meet HIPAA standards could adversely affect demand for our products and services and force us to expend significant capital, research and development and other resources to modify our products or services to address the privacy and security requirements of our customers.

     States and foreign jurisdictions in which we or our customers operate have adopted, or may adopt, privacy standards that are similar to or more stringent than the federal HIPAA privacy standards. This may lead to different restrictions for handling individually identifiable health information. As a result, our customers may demand information technology solutions and services that are adaptable to reflect different and changing regulatory requirements which could increase our development costs. In the future, federal or state governmental authorities may impose new data security standards or additional restrictions on the collection, use, transmission and other disclosures of health information. We cannot predict the potential impact that these future rules, may have on our business. However, the demand for our products and services may decrease if we are not able to develop and offer products and services that can address the regulatory challenges and compliance obligations facing our customers.

Our products and content are used to assist clinical decision-making and provide information about patient medical histories and treatment plans; If our products fail to provide accurate and timely information or the treatment methodologies suggested by our content are faulty, our customers could assert claims against us that could result in substantial cost to us, harm our reputation in the industry and cause demand for our products to decline

     We provide products and embedded content that assist in clinical decision-making, suggest treatment methodologies, provide access to patient medical histories and assist in creating patient treatment plans. If our software fails to provide accurate and timely information, or if treatment methodologies utilizing our content or practice guidelines is determined to be faulty, customers could assert liability claims against us. Litigation with respect to liability claims, regardless of its outcome, could result in substantial cost to us, divert management’s attention from operations and decrease market acceptance of our products. We attempt to limit by contract our liability for damages arising from negligence, errors or mistakes. In addition, we require that our customers approve all system rules and protocols. Despite these precautions, the limitations of liability set forth in our contracts may not be enforceable or may not otherwise protect us from liability for damages. We maintain general liability insurance coverage, including coverage for errors or omissions. However, this coverage may not continue to be available on acceptable terms or may not be available in sufficient amounts to cover one or more large claims against us. In addition, the insurer might disclaim coverage as to any future claim. One or more large claims could exceed our available insurance coverage.

     Highly complex software products such as ours often contain undetected errors or failures when first introduced or as updates and new versions are released. It is particularly challenging for us to test our products because it is difficult to simulate the wide variety of computing environments or treatment methodologies that our customers may deploy or rely upon. Despite testing, from time to time we have discovered defects or errors in our products. Defects, errors or difficulties could cause delays in product introductions and shipments, result in increased costs and diversion of development resources, require design modifications or decrease market acceptance or customer satisfaction with our products. In addition, despite testing by us and by current and potential customers, errors may be found after commencement of commercial shipments, resulting in loss of or delay in market acceptance.

If we undertake additional acquisitions, they may be disruptive to our business and could have an adverse effect on our future operations and the market price of our common stock

     An important element of our business strategy has been expansion through acquisitions. Since 1997, we have completed eleven acquisitions.

     Any future acquisitions would involve a number of risks, including the following:

	•		The anticipated benefits from any acquisition may not be achieved. The integration of acquired businesses requires substantial attention from management. The diversion of management’s attention and any difficulties encountered in the transition process could hurt our business.
	•		In future acquisitions, we could issue additional shares of our capital stock, incur additional indebtedness or pay consideration in excess of book value, which could have a dilutive effect on future net income, if any, per share.
	•		New business acquisitions must be accounted for under the purchase method of accounting. These acquisitions may generate significant intangible assets and result in substantial related amortization charges to us.

If we fail to attract, motivate and retain highly qualified technical, marketing, sales and management personnel, our ability to execute our business strategy could be impaired

     Our success depends, in significant part, upon the continued services of our key technical, marketing, sales and management personnel, and on our ability to continue to attract, motivate and retain highly qualified employees. Competition for these employees is intense. In addition, the process of recruiting personnel with the combination of skills and attributes required to execute our business strategy can be difficult, time-consuming and expensive. We believe that our ability to implement our strategic goals depends to a considerable degree on our senior management team. The loss of any member of that team could hurt our business.

Changing customer requirements could decrease the demand for our products, which could harm our business and decrease our revenues

     The market for our products and services is characterized by rapidly changing technologies, evolving industry standards and new product introductions and enhancements that may render existing products obsolete or less competitive. As a result, our position in the healthcare information technology market could erode rapidly due to unforeseen changes in the features and functions of competing products, as well as the pricing models for such products. Our future success will depend in part upon our ability to enhance our existing products and services, particularly our ability to continue to release our products onto the .NET Framework under the SunriseXA initiative, and to develop and introduce new products and services to meet changing customer requirements. The process of developing products and services such as those we offer is extremely complex and is expected to become increasingly complex and expensive in the future as new technologies are introduced. If we are unable to enhance our existing products or develop new products to meet changing customer requirements, demand for our products could suffer.

We depend on licenses from third parties for rights to the technology used in several of our products, and if we are unable to continue these relationships and maintain our rights to this technology, our business could suffer

     We depend upon licenses for some of the technology used in our products from a number of third-party vendors, including Computer Corporation of America, Computer Associates, Oracle Corporation and Microsoft. Most of these licenses expire within one to five years, can be renewed only by mutual consent and may be terminated if we breach the terms of the license and fail to cure the breach within a specified period of time. We may not be able to continue using the technology made available to us under these licenses on commercially reasonable terms or at all. As a result, we may have to discontinue, delay or reduce product shipments until we obtain equivalent technology, which could hurt our business. Most of our third-party licenses are non-exclusive. Our competitors may obtain the right to use any of the technology covered by these licenses and use the technology to compete directly with us. In addition, if our vendors choose to discontinue support of the licensed technology in the future or are unsuccessful in their continued research and development efforts, particularly with regard to Microsoft, we may not be able to modify or adapt our own products.

Our products rely on our intellectual property, and any failure by us to protect our intellectual property, or any misappropriation of it, could enable our competitors to market products with similar features, which could reduce demand for our products

     We are dependent upon our proprietary information and technology. Our means of protecting our proprietary rights may not be adequate to prevent misappropriation. The laws of some foreign countries may not protect our proprietary rights as fully as do the laws of the United States. Also, despite the steps we have taken to protect our proprietary rights, it may be possible for unauthorized third parties to copy aspects of our products, reverse engineer our products or otherwise obtain and use information that we regard as proprietary. In some limited instances, customers can access source-code versions of our software, subject to contractual limitations on the permitted use of the source code. Furthermore, it may be possible for our competitors to copy or gain access to our content. Although our license agreements with these customers attempt to prevent misuse of the source code or trade secrets, the possession of our source code or trade secrets by third parties increases the ease and likelihood of potential misappropriation of our products. Furthermore, others could independently develop technologies similar or superior to our technology or design around our proprietary rights. In addition, infringement or invalidity claims or claims for indemnification resulting from infringement claims could be asserted or prosecuted against us. Regardless of the validity of any claims, defending against these claims could result in significant costs and diversion of our resources. The assertion of infringement claims could also result in injunctions preventing us from

distributing products. If any claims or actions are asserted against us, we might be required to obtain a license to the disputed intellectual property rights, which might not be available on reasonable terms or at all.

Provisions of our charter documents and Delaware law may inhibit potential acquisition bids that a stockholder may believe is desirable, and the market price of our common stock may be lower as a result

     Our board of directors has the authority to issue up to 4,900,000 shares of preferred stock. The board of directors can fix the price, rights, preferences, privileges and restrictions of the preferred stock without any further vote or action by our stockholders. The issuance of shares of preferred stock may discourage, delay or prevent a merger or acquisition of our company. The issuance of preferred stock may result in the loss of voting control to other stockholders. We have no current plans to issue any shares of preferred stock. In August 2000, our board of directors adopted a shareholder rights plan under which we issued preferred stock purchase rights that would adversely affect the economic and voting interests of a person or group that seeks to acquire us or a 15% or more interest in our common stock without negotiations with our board of directors.

     Our charter documents contain additional anti-takeover devices including:

	•		only one of the three classes of directors is elected each year;
	•		the ability of our stockholders to remove directors without cause is limited;
	•		the right of stockholders to act by written consent has been eliminated;
	•		the right of stockholders to call a special meeting of stockholders has been eliminated; and
	•		advance notice must be given to nominate directors or submit proposals for consideration at stockholder meetings.

Section 203 of the Delaware corporate statute may inhibit potential bids to acquire our company. We are subject to the anti-takeover provisions of the Delaware General Corporation Law which prohibits us from engaging, under specified circumstances, in a business combination with any interested stockholder for three years following the date that the interested stockholder became an interested stockholder, unless our board of directors or a supermajority of our uninterested stockholders agree. For purposes of Delaware law, a business combination includes a merger or consolidation involving us and the interested stockholder, and the sale of more than 10% of our assets. In general, Delaware law defines an interested stockholder as any holder beneficially owning 15% or more of the outstanding voting stock of a corporation and any entity or person affiliated with or controlling or controlled by the holder.
These provisions could discourage potential acquisition proposals and could delay or prevent a change in control transaction. They could also have the effect of discouraging others from making tender offers for our common stock. As a result, these provisions may prevent the market price of our common stock from increasing substantially in response to actual or rumored takeover attempts. These provisions may also prevent changes in our management.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     We do not currently use derivative financial instruments. We generally buy investments that are highly liquid. Based upon the nature of our investments, we do not expect any material loss from our investments.

     Investments in both fixed-rate and floating-rate interest-earning instruments carry a degree of interest rate risk. Fixed-rate securities may have their fair market value adversely impacted due to a rise in interest rates, while floating-rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fall short of expectations due to changes in interest rates, or we may suffer losses in principal if forced to sell securities that have seen a decline in market value due to changes in interest rates. The following table illustrates potential fluctuation in annualized interest income based upon hypothetical values for blended interest rates and cash and marketable securities account balances.

     Annualized interest income based upon hypothetical values for cash and marketable securities combined balances and interest rates:*

		Combined cash and cash equivalents and
Hypothetical		marketable securities balances (in thousands)
Interest Rate		$100,000				$110,000				$120,000
1.5%			1,500				1,650				1,800
2.0%			2,000				2,200				2,400
2.5%			2,500				2,750				3,000
3.0%			3,000				3,300				3,600
3.5%			3,500				3,850				4,200
4.0%			4,000				4,400				4,800

     We account for cash equivalents and marketable securities in accordance with SFAS No. 115. “Accounting for Certain Investments in Debt and Equity Securities.” Cash equivalents are short-term highly liquid investments with original maturity dates of three months or less. Cash equivalents are carried at cost, which approximates fair market value. Marketable securities consist of funds that are highly liquid and are classified as available-for-sale. Marketable securities are recorded at fair value, and unrealized gains and losses are recorded as a component of other comprehensive income.

     We do not currently enter into foreign currency hedge transactions. Through June 30, 2005, foreign currency fluctuations have not had a material impact on our financial position or results of operations.

PART II.

ITEM 1. LEGAL PROCEEDINGS

     We and our subsidiaries are from time to time parties to legal proceedings, lawsuits and other claims incident to their business activities. Such matters may include, among other things, assertions of contract breach, claims for indemnity arising in the course of our business and claims by persons whose employment has been terminated. Such matters are subject to many uncertainties and outcomes are not predictable with assurance. Consequently, management is unable to ascertain the ultimate aggregate amount of monetary liability, amounts which may be covered by insurance or recoverable from third parties, or the financial impact with respect to these matters as of the date of this report. However, based on our knowledge at the time of this report, management believes that the final resolution of such matters pending at the time of this report, individually and in the aggregate, will not have a material adverse effect upon our consolidated financial position, results of operations or cash flows.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

(a) The Annual Meeting of Stockholders was held on June 29, 2005.

(b) Two Class 1 directors were elected to serve for a term of three years ending at the 2008 annual meeting of stockholders. The two Class 1 directors are Eugene V. Fife and Braden R. Kelley. Continuing directors included two Class 2 directors, Steven A. Denning and Jay B. Pieper, and two Class 3 directors, Dan L. Crippen and Edward A. Kangas.

(c) The following describes the voting on each matter considered at the meeting.

						Votes
						Against or								Broker
Matter		Votes For				Withheld				Abstain				Non-votes
1. Election of Directors
Eugene V. Fife			42,799,388				1,467,398
Braden R. Kelley			43,801,702				465,084
2. Approval of the Company’s 2005 Stock Incentive Plan and authorization for issuance of 2,000,000 new shares of the Company’s common stock there under, plus up to an additional 8,328,635 shares previously approved and available under predecessor plans.			27,689,823				8,541,289				87,979				7,947,695
3. Approval of the Company’s 2005 Employee Stock Purchase Plan and authorization for issuance of 1,000,000 shares of the Company’s common stock there under.			35,852,908				394,323				71,860				7,947,695
4. Ratification of the selection of PricewaterhouseCoopers LLP as the Company’s registered public accounting firm for the fiscal year ending December 31, 2005.			44,065,553				165,735				35,498